1. Field of the Invention
The present invention relates to transactions, and, more particularly, to mitigating risk and optimizing gain between multiple parties in multiple transactions in involving state-dependent and path-dependent conditions where outcomes maybe jointly interdependent between parties and across transactions.
2. Description of the Related Art
Offsetting risk associated with transactions, particularly involving tangible and intangible assets, is known in the art. Known products in the marketplace include those incorporating asset/liability management and economic capital allocation. Products incorporating these models operate to net and offset multi-lateral financial claims within financial intermediation vehicles and trading environments.
In asset/liability management systems, known applications attempt to match amounts that a party owes (or what that party might owe in the future) to assets and capital that the party owns. Asset/liability management models are employed to strike a balance between, for example, a current value of an asset and its current use, including what the asset is able to generate in terms of current income from its use, and the asset's terminal appreciation or depreciation. Asset/liability management systems evaluate how a party's various states evolve over time, and the effect of those states with respect to cash flow. In a typical borrowing arrangement, a party borrows X dollars, and the party uses the money to purchase Y asset. Use of the Y asset results in Z amount of money being earned. The party uses the Z amount of money earned by using the Y asset to repay the X dollars. In connection with this simple example, asset/liability management systems function to ensure that the Z amount of money is sufficient to pay back the X dollars (plus interest), given fluctuations in value of the Y asset and fluctuations in the current and relative value of X dollars plus interest.
Economic capital allocation systems take into consideration the present values of cash inflows and cash outflows, as determined via asset/liability management models, and further determine the cost of capital in case the borrowing party was to allocate capital, for example, in connection with a first alternative action (A), a second alternative action (B) or a third alternative action (C). Thus, economic capital allocation models estimate possible paths of future cash flows (both in and out) given certain conditions, calculate values of a party's assets versus that party's obligations, and attempt to determine a particular path that maximizes return. In other words, unlike simpler asset/liability management systems, economic capital allocation systems try to ensure that not only are debts are paid by a party, but that the party has maximized his return relative to some level of risk.
Prior art applications, therefore, calculate tradeoffs between an asset's value in a given market and the asset's use or disposition, including credit risk that might give rise to adverse risk-shifting and asset substitution, and require contingent allocation of control rights as a mitigant. Unfortunately, such systems are labor-intensive and involve exposing counterparties to unacceptable amounts of basis and settlement risk. For example, prior art systems fail to effectively parse fundamental asset risks, market risks (price volatility, value at risk, liquidity, interest rates), credit (counterparty default and spread risk), and/or operational risks. Also, prior art solutions fail to effectively disaggregate and recombine dynamically evolving risks, and do not effectively map between state-dependent probabilities, decisions, and values across counterparties. Further, prior art systems fail to adequately account for informational asymmetries, such as private information or unobservable/unverifiable actions, and also costly verification of both states and types, especially where autonomy and anonymity may be necessary, or multiple equilibria (i.e. switching between cooperative and noncooperative regimes). Such states may result in moral hazard and adverse selection, resulting in holdup, risk-shifting, predation, asset substitution, and other forms of opportunistic wealth expropriation behaviors. Such behaviors tend to proliferate under conditions where costly monitoring/verification and contract imperfection results in incomplete state-spanning by market transactions.
Other shortcomings in the prior art include a failure to adequately account for transactions across parties with multi-attribute valuations/utilities, adaptive utilities, and/or non-stationary statistical processes. Moreover, prior art systems do not adequately address uncertain time horizons and entry/exit of counterparties between the initial and final states (i.e. initial and terminal trade dates) in an open system.